The economic upturn in the Caucasus and Central Asia is gathering momentum, with growth for the region projected to increase to 5¾ percent in 2010, up from 3½ percent in 2009, the International Monetary Fund (IMF) said in its Regional Economic Outlook for Caucasus and Central Asia (CCA) released in Almaty today. According to the report, fiscal stimuli applied by many governments in the region—together with a favorable external environment—have helped spur the recovery from the global crisis. The report notes that the upturn in Russia’s economy has benefited the region as well, mainly through trade and remittance channels (see chart), as has the rise in hydrocarbon prices.

“The outlook for the region is broadly positive, although in some countries it will take time for per capita disposable income to return to pre-2009 levels,” said Middle East and Central Asia Department Deputy Director David Owen.

Sustained growth for energy exporters

According to the report, growth in 2010 is expected to be strongest among the region’s oil and gas exporters, with projections ranging from 4½ percent in Azerbaijan to 9½ percent in Turkmenistan. With oil prices expected to remain near $80 per barrel in 2011, these countries should grow at similar rates in 2011.

Russia’s upturn helps energy importers

Among the oil and gas importers, Armenia and Georgia are forecast to grow at 4 percent and 5½ percent, respectively, in 2010, compared with negative growth in 2009. In Tajikistan, growth is estimated at 5½ percent for 2010—about 2 percentage points higher than in 2009. Buoyed by Russia’s recovery, all three countries are projected to grow at 4–5 percent in 2011.

In the Kyrgyz Republic, political and ethnic turmoil earlier in the year are weighing heavily on this year’s performance. Economic activity is expected to shrink by 3.5 percent in 2010, but bounce back strongly in 2011 and grow by a projected 7 percent.

Inflation needs to be watched closely

Inflation across the CCA region as a whole has come down from high pre-crisis levels, and underlying inflationary pressures are expected to remain contained over the next year, the report notes. In a few countries, however, headline inflation has been impacted significantly by the recent spike in food—especially wheat—prices, and policymakers will need to monitor developments closely. In Uzbekistan, continued fiscal stimulus, combined with lower interest rates and directed lending, raise the risk of a further buildup in inflationary pressures—a possibility that Turkmenistan also faces.

Risks ahead

Despite the region’s apparent recovery, risks remain, the report says. In particular, a weaker-than-expected recovery in Russia would adversely affect trade and remittance flows to the region. Slower-than-expected growth in advanced economies would also weaken economic activity in the region, mainly through a drop in demand for oil and gas. And continued banking sector weaknesses sector could hold back credit growth and weigh on the economic outlook.

Policy response

With regard to the policy response, the report recommends that countries across the region use the current recovery to start winding down policies that were implemented in response to the crisis. When unwinding, the authorities should first exit from fiscal stimulus, in light of fiscal sustainability considerations, the report adds. This is particularly true for oil and gas importers, which are facing rising public debt as a result of their policy response to the crisis and declining donor support.

Turning to monetary policy, the IMF says that it can remain accommodative for now, not least because banking sectors in many countries remain impaired—particularly in Kazakhstan, where there are high levels of nonperforming loans. At the same time, the report warns that authorities need to pay close attention to inflation developments and act quickly, if necessary, to prevent an increase in inflation expectations.

In CCA oil and gas importers, current account deficits remain high, especially in Georgia and Armenia. Foreign direct investment inflows in most countries have not yet returned to pre-crisis levels, and external debt is high and rising. Going forward, policymakers should therefore focus on reining in current account deficits to help preserve external sustainability.

For the CCA oil and gas exporters, managing hydrocarbon wealth by ensuring an efficient use of public resources remains a key medium-term policy challenge. “Looking ahead, it will be important for these countries to develop their non-oil economy while managing hydrocarbon wealth wisely,” Mr. Owen said. “Laying the basis for high and sustained growth will also require that the authorities speed up structural reforms aimed at improving the business environment and creating more room for private-sector activity,” Mr. Owen concluded.